Westpac's Phil Coffey goes into bat for big banks on capital levels

James Eyers and Clancy Yeates

The Financial System Inquiry led by David Murray significantly underestimated the capital levels of Australia's big banks, which have been substantially strengthened since the financial crisis,Westpac deputy chief executive Phil Coffey said.

The banking industry believes Mr Murray made a mistake in his interim report, which undercuts his push for the big banks to hold more capital and reduce their exposure to mortgages.

In suggesting Australia's banks might be forced to raise more equity to make them safer, Mr Murray said in the inquiry's interim report the big banks' common equity tier 1 (CET1) capital levels were "around the middle of the range relative to other countries" – at a level of 10 per cent.

However, a report by PwC attached to the second-round submission to the inquiry from the Australian Bankers' Association said the real CET1 ratio is "in the range of 11.5 per cent to 12.5 per cent" for the major banks.

Even at the lower end of that range, this would put the big four banks "at or above the 75th percentile of bank capital relative to the most appropriate comparator set of global banks", PwC found in a detailed analysis.

Advertisement

Mr Coffey said: "We think we should be strongly capitalised, and we are when you look at the highest-quality level of capital. On the basis we are already in the upper quartile of global peers, there doesn't seem to be a pressing requirement to add in more of that form of capital."

The banks said the discrepancy was a result of Mr Murray relying on data from the Australian Prudential Regulation Authority and Basel Committee on Banking Supervision, which had not been adjusted to reflect APRA's conservatism compared to the Basel global framework. PwC found 11 areas where APRA is tougher, including requirements for modelling risk in mortgage books and requiring deductions from capital for certain tax and intangible assets. The interim report did acknowledge that different definitions of capital limited international comparability.

PwC also found the BCBS data was out of date. "We also note that the data is now over one year old."

You will now receive updates fromBusiness AM Newsletter

Business AM Newsletter

Mr Coffey said market pressures had encouraged Australian banks to strengthen capital levels since the global financial crisis.

"What the regulator has been looking to achieve and what bank managers have been looking to achieve have been very tightly aligned for quite a few years," he said. "Global investors have been saying we want you to be demonstrably strong on your capital, we want you to change your funding mix, and if you do we will continue to buy your long-term bonds. We wouldn't disagree with comments from the inquiry that major banks should be strong."

Westpac's second submission to the inquiry also rejects Mr Murray's suggestion that growth in mortgage lending may be creating systemic risks. The bank said increases in housing finance were demand-driven and underpinned by sound economic fundamentals and the Australian market was showing no signs of over-indebtedness by borrowers, high-risk loans on non-commercial terms or any supply-driven concentration of housing assets on bank balance sheets.

With Mr Murray signalling the final report of the inquiry will seek to reduce moral hazard created by big banks being perceived as being "too big to fail", Mr Coffey said it was important to distinguish between liquidity support of the financial system in a crisis and taxpayer-funded government bailouts of failed banks. The later were "totally inappropriate", he said, but support by central banks during a liquidity crunch "is a sensible thing in the best interest of the taxpayer".

Increased stress testing could be used to assess additional regulatory and prudential measures to deal with "too big to fail", while Mr Coffey rejected the need for banks' retail operations to be "ring-fenced" from more speculative activity to protect depositors, pointing to the modest scale of investment banking-style activity by Australian banks and huge costs.

"The administrative costs of setting up ring fences around the globe have been horrific," he said. "It has always been more complex and costly than you think, and we can't see any benefit for customers or much benefit for the safety of the system" because less than 5 per cent of the activities of Australian banks would sit outside the fence, he said.

"It's a solution for another problem."

With the G20 summit in Brisbane in November examining models for bondholder "bail-in" of failed banks, Mr Coffey said there was no clear advantage in Australia being an "early mover" and "if it is necessary, there is a lot of thinking about how that arrangement takes place".

With the interim report suggesting that regional banks might be given assistance to increase the quality of their risk modelling which would allow them to reach "advanced accreditation" standards under global rules and hence use a lower risk weighting for mortgages, Mr Coffey said it would be fair for smaller banks to receive some relief on mortgage weightings as they improved their systems rather than the current "all or nothing" approach.

The inquiry secretariat said it has received "substantially more" second-round submissions than the 280 it received in the first round and will publish them on Friday.